Homebuilders face cost pressure as Russia tightens rules on presales

July 4, 2018

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A new law forcing Russian homebuilders to use bank loans to fund construction rather than relying on cash from selling homes before they are complete will add to costs and encourage industry consolidation, developers said.

Homebuilders, such as PIK, LSR and Etalon, put flats up for sale when ground is barely broken on construction sites and sell most before completion.

Russians spend hundreds of billions of roubles a year buying yet-to-be-built apartments, effectively co-financing construction so developers do not need to raise debt financing.

Buying an apartment when building starts can cost 40 percent less than the equivalent finished flat, making it a popular practice. Prices rise as construction progresses.

But the scheme has been misused. Russian authorities have in the past two years had to help out about 30,000 customers of insolvent real estate developer Su-155 which failed to hand over pre-paid flats.

Last year, homebuyers from the Siberian city of Krasnoyarsk, who were left without flats they had paid for, travelled more than 3,000 km (1900 miles) to Moscow to protest after the local authorities were unable to solve their case.

As protests gained pace, President Vladimir Putin ordered his government to restrict financing of housing construction with the funds of flat buyers, gradually replacing the scheme with bank loans and other financing instruments.

New rules, designed to protect apartment buyers that are due to come into force in July 2019 but which still await Putin’s final approval, will ban homebuilders from taking customers’ money before construction is completed.

During a year-long transition before the law takes full effect next year, developers will be monitored on their use of cash that has been paid for unfinished flats.

Big players are in a better position to adapt to the new rules but would still have to raise prices to offset higher financing costs or face a squeeze on margins, developers said, adding that smaller players could be pushed out of the market.

“At first the law will lead to a rise of costs and a fall in margins, then the least efficient market players will be out, resulting in a decrease in supply and price growth,” said Kirill Bagachenko, the CFO of Etalon.

Nikolay Krainov, co-owner of medium-sized residential and commercial property developer IG Pokrov, said his company would shift from housing projects to focus on commercial real estate.

“The legislative amendments, especially those that will come into force from July 2019, will lead to big players getting bigger and the monopolisation of the market,” said Tatiana Makarova, vice president at developer FSK Lider.

PIK, Russia’s largest housing developer, said it would comply with the new rules and saw no risk of sales being disrupted by the change.

The company announced it was raising prices from July 1, but said that while the new legislation had played a role, the move was mainly due to the falling interest rates on mortgage loans.

“The law will lead to a rise of prices per square metre, to the disappearance of many medium-sized and small developers. That’s a fact. Because too much resources will be needed to comply,” Igor Evtushevsky, CEO of Samolet Development, told Reuters.

During the year of transition, money paid for flats still under construction must be deposited into escrow accounts at authorised banks which will control the use of the funds.

From July 2019, payments for homes must be deposited into escrow accounts until the construction is completed.